Correction in yen was overdue and may be ‘healthy’: former ECB head
The recent rapid strengthening of the Japanese yen can be seen as an overdue and healthy correction — and it’s not time to panic about the wider market impact, the former head of the European Central Bank said Tuesday.
A combination of Japanese monetary policy turning hawkish, geopolitical tensions in the Middle East and disappointing U.S. jobs data rattled markets around the world across Friday and Monday, Jean-Claude Trichet told CNBC’s “Squawk Box Europe.”
“The three have played their role, in my opinion, in triggering this [U.S. dollar-yen] correction which was nevertheless overdue, because everybody knew that the yen was not in an appropriate position, and the carry trade had been, I would say, very active during a long period of time,” Trichet, also formerly the governor of France’s central bank, said.
A “correction” is generally defined as a drop in the value of an asset or index by 10% or more, returning it closer to a long-term trend.
A carry trade involves an investor borrowing a currency with low interest rates and reinvesting it in higher-yielding assets elsewhere — taking advantage of that differential to make a financial gain. Investors piled into yen carry trades in recent years, attracted by Japan’s low volatility and ultra-loose monetary policy.
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U.S. dollar/Japanese yen
But a rapid appreciation in the yen began last Wednesday, when the Bank of Japan raised its benchmark interest rate and set out a plan to taper its bond-buying program.
The U.S. dollar plunged nearly 5% against the yen last week, and lost further ground on Monday — though ticked 0.5% higher Tuesday. Global stock markets meanwhile plunged as “safe haven” assets such as the Swiss franc and U.S. Treasurys were bolstered.
“You can’t unwind the biggest carry trade the world has ever seen without breaking a few heads,” Kit Juckes, chief foreign exchange strategist at Societe Generale, said in a Monday note.
Trichet told CNBC Tuesday: “The correction can be seen as a healthy correction, in some respects. We will see, of course, we have to remain extremely prudent and cautious, but we have good explanations for the correction we … observed last Friday and yesterday.”
“It was overdue, probably, and we have a set of positives in the U.S., in Europe, in the global economy, which are there still and are justifying no panic — no panic, which, it seems to me, is very, very important in the present juncture.”
“I don’t see a reason to panic on the United States,” Trichet added, pointing to the U.S. composite purchasing managers’ index for July, which remained in growth territory.
U.S. recession talk erupted last week following a weaker-than-expected July jobs report, though some economists and Federal Reserve policymakers dismissed the idea that the data indicated a severe downturn.
Markets, already convinced the Fed will cut interest rates at its next meeting in mid-September, have since increased bets on a 50 basis point cut rather than 25 basis points to nearly 75%, according to CME Group’s FedWatch tool.
Some have also speculated the central bank may need to enact an emergency cut between its scheduled meetings.
However, Trichet said Tuesday that while the Fed may be “hesitating” between 25 and 50 basis points, the current data did not support an emergency cut.
“Taking into account all what we know, I don’t see that it would be, I would say, thinkable, that the Fed would give such an element of — I wouldn’t say panic, but an element of anxiety which is not necessarily justified,” he said, adding that more data would present a clearer picture in the coming weeks.
Pointing to another sign of economic strength, Trichet said that while inflation remains above target in the U.S. and euro zone, there has been a sustained period of disinflation for which central banks should be credited.
“I conclude in saying that in some respect, what has happened [in markets] which was not foreseen, can be interpreted as a healthy correction, but I remain very cautious and prudent,” he said.
— CNBC’s Sam Meredith and Lim Hui Jie contributed to this report
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